At first glance, the valuation of intellectual property may not be the first thing you think of during the course of a commercial bankruptcy. While most hard assets, such as accounts receivable, inventory and tangible assets, are already pledged as collateral, intellectual property – including trade secrets, permits and patents – can represent a ”hidden” value of the debtor. Although the Bankruptcy Code definition of intellectual property doesn’t include trade names and trademarks, the latter are also frequently a consideration during commercial bankruptcy proceedings.
To better understand the connection between intellectual property and commercial bankruptcy proceedings, it’s useful to examine how the three generally accepted intangible asset valuation approaches apply in the bankruptcy environment: cost, market and income.
The cost approach is based on the theory an investor will pay no more for an asset than the cost to obtain an asset of equal utility. While not as commonly used as income- and market-based approaches when valuing intangible assets, the cost approach may be used to value software or technology that is very early in the development process.
The market approach is often used in the valuation of patents, trademarks, technology and certain copyrights. The most common market approach used is the relief from royalty method, which values an intangible asset based on the benefit of ownership through the avoidance of the theoretical royalty it would have had to pay to “rent” the intangible if it wasn’t owned.
The income approach determines the value of an intangible asset based on the present value of the expected cash flows attributed to that asset. The income approach is typically used to value patented or unpatented trade secrets as well as certain trademarks and copyrights. If an owner is able to either experience increased revenue or decreased costs as a result of a specific intangible, this approach would likely apply.
When it comes to Ch. 7, 9 and 11 bankruptcy proceedings, the valuation of intellectual property provides a much clearer picture of the debtor’s full value. A valuation analyst experienced in intellectual property valuations can help determine the value of intangible assets that have not been pledged as secured debt collateral.
About the Author
Howard Klein, CPA / CFE / CIRA / CVA, is a leader in the firm’s Valuation and Litigation Advisory Group. His areas of expertise include valuations, bankruptcy and fraud investigations, and accounting, auditing & review services. Howard has served as an expert accounting witness in numerous cases involving bankruptcy, fraud, contract disputes, lost profits, valuations, and domestic issues.